A "Private" Moment on Wall Street The Rude Awakening
Melbourne, Australia
Monday, January 22, 2007 - Energy's "January sale" heats up,
- Private equity takes to The Street with a formidable arsenal,
- Bidders and losers - crunch time in the buyout frenzy and much more…
Eric Fry, reporting from Laguna Beach, California… "My view is that this is the 'January Sale' for oil investments," Byron King declared last week. "The best companies on the planet are selling at massive discounts. You can buy reserves in the ground, and the means to extract them, at dirt-cheap (excuse the pun) prices. Byron, who is a former geologist and a current contributor to our sister publication, Whiskey and Gunpowder, continued: "Two companies that you always want to own in a rising oil market, but can never seem to afford because the big institutions bid them up, are Baker Hughes (BHI), a drill bit maker, and Schlumberger (SLB), an oil field services provider. In the past two months, both have tumbled sharply. They are relative bargains, and in any oil recovery will make up their recent losses like the space shuttle lifting off from the pad. Be patient, but watch for the spark of ignition."
To read the rest of Byron's views about current opportunities in the energy sector, as well as those of several other commodity market experts, check out the January 19 edition of the Rude Awakening, "Oil Plays Dead." Byron is not the only investor who's expressing an opportunistic interest in the flamed-out energy sector. In the recent Barron's roundtable, John Neff, the long-time portfolio manager of the Vanguard Windsor Fund, recommended Nabors International (NYSE: NBR), while Goldman Sach's Chief U.S. Investment Strategist, Abby Joseph Cohen, recommended Baker Hughes (NYSE: BHI). "This may not be a great year for energy," said Cohen, "but the longer-term patterns are constructive…The stock is selling at a discount to some of its peers, like Schlumberger (NYSE: SLB)…" As one of the ultimate Wall Street insiders, Ms. Cohen would be privy to the approximate investment interests of Goldman's major clients - both the hedge funds and the private equity funds. It is possible, therefore, that Cohen sees Baker Hughes as not merely a beaten-down blue chip, but also as a prospective acquisition target for private equity investors. Who and what are these private equity investors? And why should we care about them? They are, simply stated, investors who seek to "take companies private" - i.e. to acquire public companies and then to operate them as private concerns…at least for a while. Back in the 1980s, we referred to these folks as "corporate raiders," mostly because that's exactly what they did. They would acquire asset-rich public companies, then implement a variety of tactics and maneuvers to "extract value." Sometimes they would lay off thousands of employees; sometimes they would sell off assets; and sometimes they would do both. The private equity game has changed a bit since the 1980s. Today, the raiders of many companies are already on the payroll as overly compensated CEOs and vice-presidents. Meanwhile the private equity investors often become the legitimate champions of shareholder interests. Nevertheless, the targets of private equity investment have changed very little. Lowly valued, asset-rich companies with very little debt, remain the optimal targets. Private equity investors have always been with us, but there are many more of them today than there used to be…and they've got lots of cash burning holes in their Armani pockets. Thus, they've become increasingly potent influences in the global equity markets. That's why many successful investors consider the private equity value of a stock before investing. "We buy companies as a going concern, but we're not oblivious to private-equity values," explained Scott Black at the Barron's roundtable, as he extolled the investment virtues of Apache Corp. (NYSE: APA). Black, the founder and portfolio manager of the Delphi Value Fund, noted that Apache's reserves have grown for 21 consecutive years. "[The stock] is selling for 4.1 times enterprise value to Ebitda," he said. "It has a 25% return on equity…Net debt to equity is about 0.27. Return on total capital is more than 20%. The company is a powerhouse. This year it's going to grow 8% to 10% from the drill bit, excluding acquisitions. Forty-two percent of its reserve value is in the U.S.; 27% is in Canada, with 9% in Australia and the North Sea, and 13% in Egypt… "We have them earning about $7.90 a share this year, up from an estimated $7.55. They'll generate about $2.6 billion in net income. Depreciation and amortization are $2.1 billion. Deferred taxes are about $614 million, which gives them $5.3 billion in sources of income. They should generate $1.6 billion of free cash."
These are the kinds of numbers that cause private equity investors to salivate: Very little debt, lots of cash-flow and lots of tangible assets. So now that stocks like BHI have tumbled about 20% from their highs of last summer, they might soon become buyout targets, according to Dan Denning, the expansive thinker who produces the Australian Daily Reckoning. Based on Dan's newly minted theory, the "private equity guys" are harboring bullish intentions toward the energy sector. But they are not the only investors who are trying to pick up energy assets on the cheap. So what will happen, he wonders, if a resurgent oil price combines with opportunistic individual investors, eager to find a bargain…and big oil companies, eager to replace their reserves…and cash-laden private equity investors, eager to do a deal? Oil stocks will move much higher, Dan predicts. It's just a theory, of course, but it's a fascinating theory…and one that might produce profits throughout 2007, as Dan explains below. ---------------------------- A "Private" Moment on Wall Street
By Dan Denning
The "Great Battle for Energy Equities" will begin heating up very soon. Major oil companies around the globe will find themselves directly competing with private equity firms and their ultra-rich clients for the energy assets of publicly-listed stocks.
It's worth noting that four of the five largest merger and acquisition deals in 2006 were private equity deals. And private equity firms already have $146 billion stockpiled for a new round of acquisitions in 2007, according to PriceWaterhouseCoopers. With such a sizeable war chest, private equity firms will continue what is nothing less than, "a significant privatization of the American capital system," according to William Krisch at private equity law firm, Paul, Hastings, Jansofsky and Walker LLP. Because so many cash-laden private equity firms are prowling the financial markets, appetizing prey has become scarcer. But many of the oil services and oil exploration stocks remain extremely enticing acquisition prospects. Private equity analysts must do the same thing you and I try to do each day as investors: buy a dollar's worth of value for less than a dollar. The private equity world has added a twist: lots of leverage. By using lots of debt to acquire a company, the returns on the actual cash invested can be much higher. But the risks of debt-financing are also higher. That kind of leverage means you don't want to enter into just any sort of deal. The target acquisition must either have lots of cash per share, sell at a deep discount to sales or book value, or be in a sector in which demand is growing buy supply is scarce. At first blush, energy exploration and production companies would not seem to have the attributes of a typical private equity target. Exploring for oil and gas involves a large capital cost which must be financed through either cash flow, debt, or equity. But there are two factors which make more private equity bids for energy assets more likely, though. The first is that the supply of well-managed energy companies with good balance sheets. Private equity is keen to buy scarce and quality assets, wherever it can find them. The energy sector presents compelling value. The second factor that puts energy assets on private equity's radar is the long-term underlying scarcity of oil and gas that's driven energy stocks higher since 2004. Oil and gas are getting harder to find. Publicly traded energy conglomerates and nationally run firms are finding it harder to replace annual production with new reserves, especially because demand keeps rising and discovery of new reserves keeps falling. Therefore, private equity investors see the fundamental picture for energy assets being very bullish and would like to get in now, while credit remains cheap, energy prices remain high but stagnant, and before other bidders start arriving. There WILL be other bidders, however. That is the third and final factor leading to higher prices for energy assets in 2007. Private equity buyers will find themselves engaged in bidding wars with major oil companies, flush with cash but desperate for new sources of production, as well as countries like China and India, flush with cash from trade, but also in desperate need of secure energy supplies. It will be a great energy equity rush. And as an investor, the obvious question is which companies will be most coveted? Oil service companies and oil exploration and production companies seem particularly attractive. Oil service companies like Diamond Offshore (NYSE: DO), Global Santa Fe (NYSE:GSF), and Noble Corp. (NE) could be next. There are probably worse investment ideas, therefore, than buying these stocks for 2007. Or, if you're a speculator, buying in-the-money call options on the Oil Service Holders (AMEX: OIH), an exchange-trade fund that holds a broad portfolio of oil service stocks. The epic bull market in energy stocks is about to enter a second phase. As private equity funds battle the world's major oil companies for control for scarce energy assets, the prices of most oil stocks should move considerably higher, especially if crude oil itself, stages a modest rebound. It all adds up to a continuation of the epic bull market in energy stocks. Let the battle, and the profits, begin. --- Urgent Buyout Profile Alert --- Breakthrough! A small, under-the-radar pharmaceuticals pioneer has brought America's most dreaded disease to its knees… Gains of 30-60 times your money or MORE are all but certain if you're holding shares when Big Pharma buys it out - which could happen any day now! Read The Full Report Here. | 
